The In-House Lawyer

Warsha Kalé (left) and Dena Nurko-Lopes discuss why parents pay for subsidiary involvement in cartel activity, by considering competition law principles and the key issues for share and asset sales from the buyer and the seller viewpoint

more companies are being investigated by the European Commission (the Commission) for involvement in illicit cartel activity – the most egregious form of anti-competitive conduct – following the dramatic success of the Commission’s leniency programme.

The Commission’s leniency programme encourages companies that have participated in a cartel to ‘blow the whistle’ on their fellow cartel members by offering full or partial immunity from sanctions. This is now recognised as a pragmatic and effective solution for cartel detection, even though, as a result, the whistleblower may go unpunished (or only be partly punished) for its involvement in the cartel.

Given that fines for cartel behaviour can be very substantial, the possibility of securing a reduction of a fine has prompted numerous companies involved in cartels to confess their misdeeds to the Commission and, in doing so, implicate their co-conspirators.

It is also clear that the Commission’s campaign against cartels has on more than one occasion taken new owners of businesses involved in cartel activity by surprise. The essentially covert nature of cartels can result in arrangements of which there is little documentary evidence and that are unlikely to be discovered during the standard corporate due diligence procedures by a prospective purchaser. However, the fact that the purchasing company did not know of the target company’s involvement in the cartel is not, in itself, sufficient to protect the new owner from being found liable for a business’s ongoing infringement. Moreover, the new parent company may still be saddled with liability for competition infringements that were carried out before the purchase, even if the sale of the business is structured as an asset sale, rather than a share sale.

This article provides an overview of the general competition law principles of the liability of parent and former parent companies for anti-competitive acts carried out by their subsidiaries. The article also provides some guidance on what to look for when negotiating a share and asset sale respectively to attempt to limit liability issues that may arise in the future.

competition law principles

The primary basis for the liability of a parent company is how far it knew of, and was complicit in, its subsidiary’s infringing behaviour. This parental liability is in addition to that of its infringing subsidiary and is largely a question of fact.¹ The case law of the European Courts (the European Court of Justice (ECJ) and the Court of First Instance (CFI)) illustrates that a parent company will still be considered to be directly involved in the infringing behaviour if it was aware of it but did not intervene to stop it, for example where employees involved in the infringing behaviour were also members of the management team.²

However, where it is not possible to establish the requisite standard that the parent company had knowledge of the infringing behaviour of its subsidiary, the Commission will still be able to attribute liability to a parent company in respect of cartel activity if it is able to demonstrate that the parent company exercised so-called ‘decisive influence’ over the infringing subsidiary.

It is important to note that the question of whether a parent company had ‘decisive influence’ over its subsidiary is not necessarily linked to awareness of or involvement in anti-competitive activities.³ That is to say, the parent company can still be found to have ‘decisive influence’ over a subsidiary even where the parent company is not aware of, or involved in, the cartel activity.⁴

What is ‘decisive influence’?

‘Decisive influence’ can be presumed, and therefore liability attributed, where a parent company has a 100% shareholding in the subsidiary that has infringed the competition rules on the prohibition of restrictive practices and agreements.⁵ The Commission’s presumption of decisive influence of a parent company over the conduct of its wholly owned subsidiary is rebuttable. In practice, however, the presumption is rarely rebutted.

Decisive influence may also be found if sufficient evidence of any of the following elements is provided:

• Composition of the board – interlocking directorships or overlaps between senior management of the parent and subsidiary may support the conclusion that the parent was informed of or involved in the subsidiary’s commercial strategy.
• Management/instructions – in several cases the fact that the parent company had in fact issued instructions to its subsidiary has been an important consideration.
• Board minutes – these may provide important evidence of decisive influence by showing the manner in which the shareholders have exercised their power over a subsidiary.
• Market activities – there are some examples of the Commission accepting that a parent did not exercise decisive influence in relation to its partially-owned subsidiary on the basis that the subsidiary was the only entity with activities in the markets in which the cartel took place. However, the Commission appears to have reached the opposite conclusion in at least one other decision where it considered that the division of tasks between the entities of a group of companies was a normal phenomenon within a group of companies.

Joint and several liability

Competition law applies to ‘undertakings’ or economic units involved in a breach of the competition rules. The concept of an undertaking is based on economic substance rather than legal form and an undertaking may consist of no distinct legal entity or several different legal entities – commonly, a parent company and a subsidiary.⁶

Although the competition rules apply to undertakings, the Commission is obliged to address its infringement decisions to legal entities (as opposed to economic units).⁷ Where the conditions for attributing liability to a parent company are satisfied, the Commission enjoys a margin of discretion when deciding whether the infringing subsidiary and/or the parent company should be made the addressees of the decision.⁸ However, even though the Commission does have a margin of discretion, it will almost invariably hold a subsidiary that directly participated in an infringement liable for its involvement.

The Commission’s policy, in cases where it holds more than one legal entity within an undertaking liable – generally the infringing subsidiary and the parent company – is to attribute liability on a joint and several basis between subsidiary and the parent company. However, joint and several liability will not always or necessarily extend to the whole fine, particularly if the relevant entity’s involvement was limited in time.

Liability after a change in ownership

An issue that is often overlooked when a company purchases the shares or assets of another company is that the new owner may inadvertently open itself up to the possibility of being found liable for ongoing cartel involvement by the business it has acquired.

Where a company has sold by means of a share sale the subsidiary that was directly involved in the cartel activity, the original company (provided that it is still in existence) is likely to continue to be answerable for the period of the infringement for which it owned the subsidiary. This is provided that the conditions for attribution of liability are satisfied.⁹

However, it should be noted that if the anti-competitive behaviour continues once the infringing legal entities have been acquired by a new undertaking:

‘Liability for the infringement should be apportioned between seller and acquirer of the infringing assets, each undertaking being responsible for the period of infringement in which it participated through these assets in the cartel.’¹⁰

The Commission’s policy is that liability should be attributed on a joint and several basis to both the new owner and the infringing subsidiary it has acquired for the period of the current owner’s ownership. This is regardless of whether the current owner has only owned the infringing subsidiary for a short period of time prior to the Commission commencing a cartel investigation.¹¹ For example, in Gas Insulated Switchgear [2007], the Commission found the current owner jointly and severally liable with the relevant infringing subsidiaries, even though it had only acquired the infringing subsidiaries approximately five months before the start of the Commission’s investigation. This liability would be in addition to the joint and several liability of the former owner and the infringing subsidiary for the period of its ownership of the subsidiary.

The Commission has, in recent cartel decisions, specified the proportion of the whole fine in respect of which specific legal entities were jointly and severally liable. Therefore, where the Commission attributes liability to both current and former parent companies, the Commission effectively ring-fences the amount of the cartel fine payable by the current parent company from that payable by the former parent company.

However, although the above principles would appear to lead to an equitable apportionment of liability in theory, the imposition of joint and several liability could still result in a potentially ‘unfair’ outcome in practice. In particular, where an infringing subsidiary is held to be jointly and severally liable with its former owner, if its former owner does not pay any of the relevant portion of the cartel fine, the subsidiary would be liable for the whole of that portion. In such circumstances, the current owner of the subsidiary would be accountable for the whole of that portion, directly or indirectly, depending on how it decided to apportion the cartel fine within its corporate group. Moreover, enforcement proceedings could be brought against the current owner in respect of this portion of the fine if the current owner did not pay. The current owner would in any event also have to pay, either directly or indirectly, for the whole portion of the cartel fine for which it was held jointly and severally liable with the subsidiary.

In summary, therefore, if the former owner does not pay the portion of fine for which it was held jointly and severally liable with the subsidiary, the new owner would effectively have to pay the entire cartel fine.

Asset sales

The general position from a corporate perspective on an asset sale is that the buyer will purchase the assets free of any future liability for infringements of competition law.

However, it is important to note that the operation of competition law will mean that the buyer may be held liable for competition law infringements committed prior to the acquisition, if there is no other legal entity on which the Commission can impose a fine. Interestingly, this situation may arise irrespective of the contractual arrangements between the parties at the time of the acquisition.

Key issues for share sale

For the reasons set out above, lack of knowledge of the infringement on the part of the acquiring company at the time of the acquisition is of little assistance. Set out below is a checklist of high-level issues to consider when acting for a buyer or seller on a share sale. This checklist is only intended to provide guidance and competition law advice should always be sought on specific issues.

When acting for the buyer

1. Resist any attempt to reduce the warranty period since it may be some years before infringements are discovered and the buyer may become liable for any infringement carried out during the relevant limitation period.
2. Resist any materiality limitations on warranties. Materiality is not a straightforward issue in competition law terms, as competition law can apply to an unlawful intention, even if its actual effects are minor. Infringement decisions can have serious consequences and may damage the reputation of the business unquantifiably.
3. Implement a comprehensive competition compliance programme on completion to identify any future liability for infringements of competition law.

When acting for the seller

1. Reduce the warranty period to as short a time as possible;
2. limit the warranty to conduct that is material;
3. exclude conduct of which you are not aware; and
4. limit the warranty to specific legislation or jurisdictions.

Key issues for asset sale

Set out below is a checklist of high-level issues to consider when acting for a buyer or seller on an asset sale (which are similar to those above in respect of a share sale). Again, this checklist is only intended to provide guidance and competition law advice should always be sought on specific issues.

When acting for the buyer

1. Avoid structuring a transaction in a way that allows the seller to dissolve the legal entity that owned the acquired assets on completion. If this transaction structure is necessary, an appropriate indemnity should be obtained from the seller. This is to ensure that the liability remains with the legal entity selling the assets.
2. Consider, if appropriate, establishing a new subsidiary with identifiable turnover to hold the acquired assets, rather than merging them into a wider unit. The aim of this is to limit liability, as, if liability were transferred it could be argued that the maximum fine imposed should be based on the turnover of the subsidiary rather than the group as a whole.
3. Resist any attempt to reduce the warranty period.
4. Resist any materiality limitations on warranties.
5. Implement a comprehensive competition compliance programme on completion to identify any future liability for infringements of competition law.

When acting for the seller

1. Consider, if appropriate, dissolving the legal entity that sold the assets as the liability may then pass along with the assets to the buyer;
2. reduce the warranty period to as short a time as possible;
3. limit the warranty to conduct which is material;
4. exclude conduct of which you are not aware; and
5. limit the warranty to specific legislation or jurisdictions.

By Warsha Kale, associate director, and Dena Nurko-Lopes, associate, Berwin Leighton Paisner LLP.E-mail:warsha.kale@blplaw.comdena.nurko.lopes@blplaw.com.